Mises Wire

How Trump Will Make the Trade Deficit Worse

Donald Trump campaigned on the economic issues of international trade, immigration, and jobs. He condemned international trade, immigrants, and the economic policies of countries such China and Mexico. As such, he should be made an honorary member of the mid-19th century “Know Nothing” political party.

This week he took aim at the trade deficit by issuing two executive orders allegedly to make international trade fairer and more beneficial for Americans. One order calls for a report on trade practices that contribute to the trade deficit. The second order seeks to establish better collection practices for anti-dumping fines and countervailing duties.

Commerce Secretary Wilbur Ross attempted to downplay the significance of the executive orders and said that there are likely multiple reasons for the trade deficit. However, this position reveals a general economic ignorance regarding international trade. There is one and only one reason to worry about the trade deficit. This problem does not require any studies or reports to understand.

Austrian economists have regularly reminded us that the trade deficit does not matter. National borders are artificial contrivances that naturally create trade deficits in some countries and trade surpluses in other countries. I run continuous trade deficits with the supermarket where I shop. No big deal.

Economists will point out that a trade deficit means that your country even benefits because we get to consume more goods than we produce. If other countries are rigging their economic policies to force a trade deficit on us, we should be happy. Correct?

Why would countries continue to rig their policies to bestow a continuous flow of such presents? The answer is they don’t. It is our policies that cause the continuous trade deficit and border policy reforms will do nothing to solve it. In fact, several of President Trump’s proposals, such as increasing military spending and the trillion dollar public works program, will make the trade deficits even bigger!

Under the gold standard, trade deficits and surpluses are small and fluctuate from year to year. International gold flows tend to regulate international trade so that trade surpluses in one period cancel out trade deficits in the previous period.

Things are different under a paper-fiat standard. The US dollar is currently the primary reserve currency for central banks so that other countries will hold dollars as reserves to stabilize the value of their own currency. This would appear to be an advantageous position of which other countries are jealous. However, this position is also a guaranteed disaster in the long run.

Having the world reserve currency allows massive dollar printing — inflation — and massive government budget deficits. It is complicated, but if dollars and government bonds are flowing out of the country, then you are guaranteed to run large trade deficits. It is not a dollar-for-dollar relationship, but large government budget deficits cause large and continuous trade deficits.

The first graph is the current account balance from 1960 to the end of 2012. This reflects the trade in imports and exports of goods. The zero black line indicates a balanced trade of imports and exports and any period below the line indicates a “trade deficit.”

From 1960 (and before) until the early 1970s the current account balance was balanced. This balance is required because small surpluses and deficits in the trade for goods could necessitate payment in gold. President Nixon did not like that outflow of gold and he took the US off the Bretton Woods Gold Standard on August 15th, 1971. In the early 1970s the current account balance starts to wiggle around the zero-black line and in the second half of the 1970s begins a period of consistent and ever growing trade deficits.

The second graph is the federal budget surplus/deficit from 1900 to the present. Periods when it is in line with the zero-black line indicates a balanced federal budget, while the period below the zero-black line indicates a budget deficit and the period above the zero-black line indicates a surplus. Except for WWI and WWII the federal government budget was roughly in balance until the early 1970s. The federal budget went into regular and increasing budget deficits starting in the mid-1970s. The only exception was toward the end of the tech stock/dot.com bubble in the late 1990s when capital gains tax revenue was extremely high.

The two data series do not march lockstep with one another, but there is a clear relationship between the two. I and others have argued that when President Nixon took us off the gold standard he destroyed the fiscal responsibility that it imposed on the US Congress.

Congress could now spend more than it received in tax revenue and borrow the money to pay for the deficit. Congress could continue to borrow without any real constraint. The Federal Reserve could also buy up government debt and remit all its excess interest income back to the Treasury. Foreign central banks and investors could also be counted on, so far, to buy US government debt and this is a big deal in terms of the trade deficits. When foreigners are buying our government debt, it reduces the amount they spend on our goods.

Trade deficits are not a problem, but large and continuous trade deficits are a sign of a significant economic problem. In this case, the trade deficit is a reflection of the government budget deficits and general lack of fiscal responsibility.

Coming back now to President Trump who has proposed tax cuts, a trillion dollars of increased spending on infrastructure, and a 10% increase in military spending. This is likely going to cause a significant increase in the budget deficit and it will also likely cause an increase in the trade deficit.

You cannot solve a problem until you know what it is and what causes it. The trade deficit is really a “money problem.” The only way to stabilize and regulate global trade involves establishing a stable monetary order such as a return to the classical gold standard.

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